Lesson 1 is the well-known point about the monetary-fiscal policy mix that we have made several times: tight government budgets and (relatively) easy monetary policy can create a pro-investment macroeconomic climate by holding down real interest rates. The resulting high rates of investment should then push up productivity and real wages. Economists have been preaching this gospel for decades. And it all seemed to work out according to Hoyle (actually, quite a bit better) in the United States in the 1990s, when the 1980s mix of tax cuts and tight money was finally and decisively reversed.

But did the policy mix really drive the investment boom of the 1990s? Our two macroeconometric models are doubtful. One major reason is a channel that textbook presentations often leave out: while lower interest rates stimulate investment spending, they also boost stock market values - which in turn spur consumption (via the wealth effect) more than investment. (This is only partially offset by the fact that higher stock prices lower the cost of capital to firms.) Specifically, when we simulated the effects of tighter budgets - balanced by easier money to hold the time path of unemployment constant - most of the rise in government saving was cancelled out by lower personal saving, leaving the investment share of GDP up only slightly. The main impetus to investment, it appears, came from the surge in productivity. The underlying reality, however, is probably messier than the models recognize. For example, while faster productivity growth undoubtedly spurs both more investment and faster GDP growth, just as the models say, a rapidly growing, high-investment economy probably also speeds up (embodied) technical progress. Why else did the explosion in information technology - which was, after all, a worldwide phenomenon-yield such rich productivity dividends in the United States, but not in Europe or Japan?